Pages 72-80 of the Financial Crisis Commission cover the most contested ground of the financial crisis: the Community Reinvestment Act.

It’s an article of faith among conservatives that the fundamental cause of the crisis was excess lending to poor people and minorities.

It’s equally an article of faith among liberals that the lending had little if anything to do with the crisis.

The conservative view faces 2 powerful counter-arguments:

(1) after the year 2000, the real driver of subprime lending was the non-bank sector, not subject to the CRA; and

(2) the subprime market was just too small to tank the US financial sector. Sub-prime lending only became a threat when sub-prime loans were packaged into derivatives. The CRA did not require anyone to do that.

But the liberal view also faces a counter-argument:

Sub-prime loans were the stuff of which the toxic derivatives were made, and it was not some idle whim or fancy of the bankers that led to the proliferation of sub-prime loans.

For example, it was the pressure of the CRA that led to the invention of the concept of the “credit score” so as to diminish the discretion of lending institutions. Credit scores in turn became a driver of the expansion of credit to ever less creditworthy borrowers.

From page 74:

Former comptroller John Dugan told FCIC staff that the impact of the CRA had been lasting, because it encouraged banks to lend to people who in the past might not have had access to credit. He said, “There is a tremendous amount of investment that goes on in inner cities and other places to build things that are quite impressive. . . . And the bankers conversely say, ‘This is proven to be a business where we can make some money; not a lot, but when you factor that in plus the good will that we get from it, it kind of works.’”

Lawrence Lindsey, a former Fed governor who was responsible for the Fed’s Division of Consumer and Community Affairs, which oversees CRA enforcement, told the FCIC that improved enforcement had given the banks an incentive to invest in technology that would make lending to lower-income borrowers profitable by such means as creating credit scoring models customized to the market. Shadow banks not covered by the CRA would use these same credit scoring models, which could draw on now more substantial historical lending data for their estimates, to underwrite loans. “We basically got a cycle going which particularly the shadow banking industry could, using recent historic data, show the default rates on this type of lending were very, very low,” he said. Indeed, default rates were low during the prosperous 1990ss, and regulators, bankers, and lenders in the shadow banking system took note of this success.

The pre-1980 mortgage market was dominated by local lenders. It was highly discretionary, which enabled discrimination – but also required bankers to weed out bad risks at origination. The savings & loan crisis killed the old mortgage market.

George Bailey of It’s a Wonderful Life retired from mortgage lending forever. In the new anonymous securitized market, high-flown liberal egalitarian ideals became the material out of which self-interested and consequence-indifferent financial engineers built the biggest economic bomb since World War II.

42 Comments so far ↓

Washington NEVER pushed banks to make bad loans. First a few things about the CRA. Originally, the CRA was made law to stop “Red Lining” minority neighborhood. The banks were all too happy to accept cash deposits from those “Red Lined” neighborhood, but wouldn’t lend back into it, even to people with good credit, good jobs and a good down payment. The government said, “If you take the community’s money, you had to make QUALIFIED loans back in that community.”

Never did the CRA require banks to make loans in the “Red Lined” communities that the banks weren’t making elsewhere.

The notion that the CRA was somehow the root cause of the financial meltdown is not based on any facts whatsoever.

One of the issues that brought about the housing crisis was that the George Bailey’s of the world retired. The snapshot of going in to the local banker to take out a mortgage and that banker hold on to the paper for 30 years while the family living in the house down the street with the white picket fence paid the bank back it’s money has ended.

Today, that same scene is played like this, the realtor connects the buyer to a mortgage broker who shops for a lender for the buyer and puts them together. The lender writes the check to the seller of the home and the buyer gets the home and the lender gets the mortgage worth X number of dollars PLUS thirty years of 5% compounded interest making the mortgage worth much more than the X dollars use to pay the seller.

The lender then turns around with the mortgage paper and sell it to an investment bank for X dollars PLUS some portion of the interest upfront. With Cash in hand, the lender can start the process all over again.

The problem with this scenario is that unlike George Bailey, neither the mortgage broker or the lender has any “skin” in the game. They just sell mortgages and couldn’t care less if it ever was repaid. They’ve got their money and it on to the next customer.

Even if that were true, $100 bills on the street don’t just stay there. Such gaping holes in the market get quickly filled by competitors.

Regardless of the rhetoric, EVERYONE involved knew perfectly well that CRA’s real purpose was to FORCE lenders to hand out loans to those who, based on the numbers, did NOT deserve them at all, or at the rates offered.

Carney wrote;
” Regardless of the rhetoric, EVERYONE involved knew perfectly well that CRA’s real purpose was to FORCE lenders to hand out loans to those who, based on the numbers, did NOT deserve them at all”

[...] Did Washington Push Banks to Make Bad Loans?FrumForumThe pre-1980 mortgage market was dominated by local lenders. It was highly discretionary, which enabled discrimination ? but also required bankers to weed …and more » [...]

The CRA was mainly a requirement that banks apply even standards to their lending, and report on it. If they rejected a black applicant with an income of 35K and a FICO of 620 they had better be rejecting white pplicants with similar stats. There was never a situation in which banks were forced to make any specific loan. Moreover CRA-compliant loans defaulted at lower rates than the general population of loans when the stuff hit the fan in 2007.
And subprime loans were the initial problem. But a lot of those loans went not to low-income borrowers, but to middle-income “investors” who were flipping houses.

These pieces continue to be fascinating. There is plenty of blame to go around. IMHO the culprit was people chasing easy money. Homeowners who knew they couldn’t pay, mortgage bankers who were paid by the # of clients they brought in, not the repayment rate, investment bankers thinking they could rewrite the rule that says the riskier the investment, the higher the rate of return.

This is not a liberal/conservative issue. This is a failing of American thinking. This is a failing of our educational system to teach people critical thinking skills and basic math and economics. This is a failing of hubris for people thinking they could win all the time.

It wasn’t CRA, it was Freddie and Fannie creating a secondary market for stupidity–low and no doc loans, stated income loans, variable rate loans. When non-bank lenders (mortgage brokers) started denting banks’ market share, banks began making those loans. The theory was, “If the federal government, through Fannie and Freddie, is going to buy those from us, it must be okay and we can make money.”

Without Freddie and Fannie creating those secondary markets, the sub-prime market would never have gotten to the scope it did, and there would have been no need for derivatives and securitization of those loans.

The CRA is just one high-profile part of an end-to-end system of pressure on lenders. The pressure takes the form of laws, regulations, outside interest groups, media, and more, and it cares not a whit for “excuses” such as facts and numbers. You’d better meet a quota in your loan outlays, or you’re a “redliner”. You’d better not protect yourself, via higher interest rates, from the inevitably higher default rate from certain loan products or demographics, or you’re a “predatory lender”.

Are you just not going to ask the hard questions? Was it legal to tell an applicant for a mortgage to inflate their income to “qualify”? And whose idea was it to hand people $50k for signing a mortgage that they couldn’t afford payments for?

Lenders KNEW these mortgages were going to default. They signed them up because there was a demand for subprime mortgages to bundle and turn into securities that other investors would bet against.

Really, the information is all out there if you’d be willing to get beyond the simplistic partisan finger-pointing.

I’m sad for what has become of modern journalism. You do have to ask questions beyond what someone’s PR person or a political flunkie has handed you.

I find it an interesting piece of partisan work for Frum to state, in a previous entry on this subject, that most of the bad loans that led to the housing crisis we’re in were written for middle and upper class homeowners who basically bought too much house (not low income buyers), and then look to a law written in 1977-to bring parity in lending, not irresponsible lending- for the answer.

That said, the answer is YES. Washington DID push banks to make bad loans, and Congress and President Bush were complicit. The American Dream Downpayment Act and Zero Down Payment Act decimated the decades-long lending approach that required an equity investment for a home loan.

And Washington-specifically President Bush-sold these programs HARD. This wasn’t the only time the President urged bad lending, just the most naked.

1. “Let me first talk about how to make sure America is secure from a group of killers, people who hate — you know what they hate? They hate the idea that somebody can go buy a home.”

2. “We are here in Washington, D.C. to address problems. So I’ve set this goal for the country. We want 5.5 million more homeowners by 2010 — million more minority homeowners by 2010. (Applause.) Five-and-a-half million families by 2010 will own a home. That is our goal. It is a realistic goal. But it’s going to mean we’re going to have to work hard to achieve the goal, all of us. And by all of us, I mean not only the federal government, but the private sector, as well.”

3. “And so what are the barriers that we can deal with here in Washington? Well, probably the single barrier to first-time homeownership is high down payments. People take a look at the down payment, they say that’s too high, I’m not buying. They may have the desire to buy, but they don’t have the wherewithal to handle the down payment. We can deal with that. And so I’ve asked Congress to fully fund an American Dream down payment fund which will help a low-income family to qualify to buy, to buy.”

4. “The third problem is the fact that the rules are too complex. People get discouraged by the fine print on the contracts. They take a look and say, well, I’m not so sure I want to sign this. There’s too many words. (Laughter.) There’s too many pitfalls. So one of the things that the Secretary is going to do is he’s going to simplify the closing documents and all the documents that have to deal with homeownership.”

Little down payment, very little equity and a Washington-pushed goal to bring in homeowners, regardless of their ability to care for homes: This plus the Zero Down Payment Act was a HUGE government push toward bad lending. Stats would agree with me. Almost ALL of the loans that have gone into default over the past 6 years were written within a 6 year period of this HUD speech and had nothing at all to do with the CRA.

The invention of credit scores wasn’t to blame for giving low-credit-score people loans, it was the bank’s faults for not requiring enough collateral, payments or insurance in case they defaulted. Every single borrower that put down less than 20% had to pay a PMI, or “private mortgage insurance” that protected the bank in the case of the borrowers default. If that insurance wasn’t enough, then banks weren’t charging enough.

Furthermore, banks charged different interest rates to different people based on their credit scores. Why weren’t they charging people with low credit scores twice as much? Because they were greedy, that’s why. It’s why in 2006 F&F only backed/ ~25% of the subprime loans.

Yes, the GOP keeps banging the drum on placing the blame on a 35 year old piece of legislation, or 80 year old government entities. Anyone willing to look at it objectively can plainly see that that’s false.

“In the new anonymous securitized market, high-flown liberal egalitarian ideals became the material out of which self-interested and consequence-indifferent financial engineers built the biggest economic bomb since World War II.” Per Mr. Frum.

Or…could it also be said like this….

In the anonymous “packaging of loans sold under bundled securities,” which also used programs, such as the ** “Zero Down HUD 2004″ **ideas,eventually ended up becoming fodder for the indifferent greedy Stock Market.

Is that basically Frums opinion?

Can we insert any government program we want, or has he decided to still dodge the question, if it was the CRA?…

I just want to see if honesty to Frum is more important than being called a Rhino.

Sub-prime loans were the stuff of which the toxic derivatives were made, and it was not some idle whim or fancy of the bankers that led to the proliferation of sub-prime loans.”

That’s just stupid. It was the greed of loan brokers that led to the proliferation of sub-prime loans, and the greed of banks which led them to buy them up so they could repackage and sell them off for a profit.

And yes, Freddie and Fannie also embraced the greed.

Frankly, I don’t think enough attention has been changes in laws over the last few decades that banks pushed through (at least here in Texas) that opened the market for refinancing homes for consumer loans. For the longest time, the rules were that refinances could only apply to home improvement projects. When people started looking at their homes as speculative cash cows, it destroyed a lot of the integrity of the mortgage process imo.

But that’s a drop in the bucket, and the real problem was a corporate culture guided by market share. Middle-management that lowered risk and bent rules proved they were getting more business than the bank across the street that behaved as if real estate could lose 40% of its value in a year. When the sky didn’t fall, year after year, such precaution became outmoded.

Kurlis // Jan 31, 2011 at 7:05 am The American Left is to blame. It is their fault. They caused the financial crisis, and they should be made to pay.

Kurlis you are really going to have improve your trolling. You see the trick is to make people think that you are actually genuine. You fail rather miserably at that rather basic requirement. But keep trying, I’m sure you’ll get someone to respond to you.

Things like derivatives sale to anonymous investors and 30 to 1 leveraging should have alerted regulators and lawmakers that there were some serious moral hazards going on. But regulators and lawmakers were not concerned, not because of some law from the 70′s, but because of intellectual and regulatory capture of the people who should have known better–that the market needed regulation and oversight. Even Bill Buckley thought as much.

But this is a story that conservatives find ideologically inconvenient, to say the least. So they’re rhetorically twisting things into pretzels (blaming 30 year old laws) rather than admitting that a pre-1930′s-style unregulated market led to a race to the bottom. Anything but that!

And by the way, if we could get the story out there that this is a problem involving minorities–that would be awesome. There’s nothing quite as distracting as a heated debate involving race to make a discussion of something like derivatives impossible. Alert the Fox commentators, this is a story involving blacks and Hispanics!

If this isn’t a story about regulatory and intellectual capture, then just a simple question: The mortgage meltdown is a worldwide problem. Did the US’s 30-year-old CRA cause all the meltdowns all over the world? For instance, is the CRA the root cause of Ireland’s problems? The UK’s problems? That’s absurd. The common feature of these countries is that they all had a pre-30′s-style, unregulated shadow banking system in place. This is why this is surely a story of intellectual and regulatory capture, not about some heavily prescribed program from 30 years ago.

Also, the meltdown started in the shadow banking sector. You can point to this or that weakness, but regulated sector began melting only as a result of being tied to the system as a whole, and wouldn’t have had such problems otherwise.

This stuff should be obvious, but there are some people with big megaphones desperate to muddy the waters…

The counter-argument against the Left is tenuous at best. Quoting: “Sub-prime loans were the stuff of which the toxic derivatives were made, and it was not some idle whim or fancy of the bankers that led to the proliferation of sub-prime loans.”

Who was responsible for creating the toxic derivatives? Was it Fannie or Freddie? Was it the low-income borrowers? Was it the middle class borrowers?

No. It was Wall Street who created them. It was a way to make money off nothing but the exchange of paper.

More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.
Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year.
Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that’s being lambasted by conservative critics.

Here are facts about the crisis writ large: http://www.ritholtz.com/blog/2010/09/fannie-freddie-acquitted Fact One: Fannie and Freddie’s primary business of subsidizing conventional loans was not a driver of the housing the bubble.
Indeed, conventional loans represented less than a third of all mortgage originations during the peak price acceleration years.
Fact Two: Fannie and Freddie lost market volume during the boom.
Fact Three: The major losses to Fannie and Freddie came through their expansion into guaranteeing non-traditional loans, not through their portfolio. That is, yes like every other financial entity Fannie and Freddie were buying subprime packages in the secondary market. However, these losses were relatively mild.
Fact Four:The key change in the Fannie / Freddie business model was their expansion in the types of loans they willing to guarantee. In particular moving into the Alt-A and Interest-Only categories.
As we can see these loans began to seriously underperform as the economy deteriorated. These loans were not a part of the original “crap hidden by structure” subprime business. Fannie / Freddie borrowers on had on average credit scores above 710 and equity (or down payment) of above 25%.
Fact Five: The higher number of Alt-A and Interest Only loans combined with ultimately higher delinquency rates have meant that a plurality of losses have come from these two categories.
These loans were vulnerable not because the borrowers were poor low-credit individuals that the government was taking pity upon but because the loan concepts were predicated on rising or at least stable housing prices.
Fact Six: Areas with the largest collapse in home prices have accounted for most of Fannie and Freddie losses.
The wave of housing price increases was kicked off by changes in private label securitization. These changes left Fannie and Freddie with a smaller market share and lower absolute level of securitizations. Fannie and Freddie attempted to adjust their basic business practices to stay competitive in bubble markets and among aggressive borrowers.
These adjustment left Fannie and Freddie exposed to a large decline in housing prices. This is exactly what happened and Fannie and Freddie reaped enormous losses because of their exposure.
Had Fannie and Freddie stuck to their traditional role of guaranteeing low value traditional loans rather than trying to stay competitive in bubble areas their losses would have been substantially less.
In short, attempting to subsidize the American dream for low and moderate income families may be a fundamentally bad policy. However, it does not appear to be either the origin of the housing bubble or the source of Fannie and Freddie’s trouble.Because Republicans have no views on policy, only a series of resentments, they want to blame liberals and minorities for the crisis. The truth, alas, is not quite so simple.

(Sorry my formatting is so ugly; they went and made the site easier to use, and I am too dumb to figure it out right now. The info is all there, at least…)

Be it true, but B Frank and C Dodd do have to own up to their part in this, they had key roles in both Fannie and Freddy and dropped the ball. But I am not coming in here to recite the Cloven-Piven conspiracy crap the Right has been kicking around like some demented KGB agents for the last 2 years.

The thing that bugs me about conservative analysis sometimes, is how individuals are completely morally beholden for their actions (…. OK), while institutions, corporations, and businesses are entities without responsibility for anything but their bottom line, up to the very edgedy-edge of the law, and are only to be expected to respond to each and every real and perceived incentive accordingly.

The only way the “the CRA did it” argument works, and only works slightly, on any level, is the contention that it started the little snow ball rolling to the financial environment that eventually enabled the whole debacle, massive mortgage fraud and CDS/CDO creation and propagation and everything. None of that was ever in the original concept to remove the onerous, specific-to-lower-income-neighborhood lending refusals of the ’70s. And I would contend that the need to lower standards in lending for that was only perceived to begin with.

But what mainly strikes me (and angers me) is how the reactions and contributions of the financial sector is completely excused, as if those were autonomic responses on the part of those institutions.

What strikes me (and angers me) is why no one is in jail for selling insurance on CDS’s that they could not cover (AIG), for putting together, and selling, CDS’s, with sub-prime mortgages that were known would fail and then hedging their bets on CDS’s they didn’t even own by buying insurance from AIG then demanding that the American Taxpayer pay off their bets 100 cents on the dollar.

Minority communities are in a catch 22, are banks not lending to us because we are minorities or because we don’t have the required financial werewithal – because we are minorities.

Having 20 years in business lending (not mortgages), I never judged an application on the color of it’s skin (we only did business by phone, FedX, email, etc. so I generally did not know), however geographically depressed areas have an ethnic correlation.

Yep, repeal of Glass-Stegal certainly put this in motion. Competition among publicly traded lenders to show ever increasing quarterly profits AND do better than their competitors meant that lending standards went out the window to show profits. The same culture was encouraged at Fannie & Freddie and is the same reason that top athlete’s keep getting found with steroids – yes it’s illegal, but if I’m not the best, then I’m irrelevant. And yes, the regulators dropped the ball. Finally, yes the consumer is at fault and responsible for their own decisions, but the products that were created where designed to maximize lender profits and not easily understood by consumers.

[...] David Frum is reading the FCIC report. His post on the CRA, “Did Washington Push Banks to Make Bad Loans?,” ends with the quote: “George Bailey of It’s a Wonderful Life retired from mortgage [...]

think4yourself is right – Fannie and Freddie are latecomers to the whole securitized push-the-financing scheme, having jumped on the bandwagon under perceived pressure to not be left in the dust. Would that they would have been the conservative (conservative in the real sense!) stalwarts in the last decade!

That said, they are hybrid monstrosities, and need to be phased out after weaning them out of their currently vital role as guarantors. Even Barney Frank says as much.

There is no evidence that the CRA rule to encourage lending in low income neighborhoods caused the subprime disaster. In fact, just the opposite. CRA loans were less likely to default.

Most of the subprime loans that blew up were given out between 2002 and 2007. If you look at the numbers, most of those were given out during that period by non-bank financial institutions like Countrywide who had nothing to do with CRA. In addition, most of the loans that blew up were not necessarily with low income households. Where was subprime and the mortgage market hit the hardest? In very middle to even upper middle class neighborhoods in south Florida, Arizona, Orange Country CA, and Nevada.

“A recent study of the CRA lenders clearly shows how CRA lending did not lead to “bad lending” and that CRA loans performed better in all categories. On January 7, 2008, Traiger and Hinckley, LLP, a law firm that specializes in fair lending counsel and Community Reinvestment Act (CRA) compliance, released a report titled The Community Reinvestment Act: A Welcome Anomaly in the Foreclosure Crisis.

The study concludes that CRA regulations have meant that banks that must comply with the regulations and originate loans in their local communities, or more formally their CRA assessment areas, are substantially less likely than other lenders to make the types of loans that have contributed to the foreclosure crisis.

The results of this study show that CRA banks are 66% less likely than other lenders to make a high cost loan and 58% less likely than other lenders to originate high cost loans to low and moderate income borrowers. High cost loans are what is known as predatory lending, teaser rates, prepayment penalties with high jumps in rates.

This difference is even more pronounced in high cost loans to low and moderate income borrowers, with CRA banks pricing their loans 74 basis points lower than other lenders.

This study also finds that CRA banks are twice as likely as other lenders to retain originated loans in their portfolio. This report notes that the originate-to-distribute model, i.e., the process of loan originators selling off mortgages and servicing rights, is a major contributor to the weakening of underwriting standards.”

” CRA-covered lenders are not the source of the problem. One of CRA’s major failings, in fact, is that it only applies to banks and thrifts. Remember all the investment banks who demanded product and then sliced and diced loans until it was impossible to understand their quality?They’re not covered. Neither are the independent mortgage banks, the kinds of firms that have gone bankrupt or nearly so because of their abysmal lending practices, who regularly made about 50% of the high cost loans. Bank affiliates, another uncovered group, made about 12% of the high cost loans.

Janet Yellin, President and CEO of the Federal Reserve Bank of San Francisco recently made this point, saying “Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans, and studies have shown that the CRA has increased the volume of responsible lending to low- and moderate-income households.” And a recent study by Traiger & Hinckley LLP.”

CRA Program is to promote
investment to properties in neighborhoods that have experienced decline resulting from disinvestment…

A Community Reinvestment Area (CRA) provides tax abatement to promote new construction or rehabilitation of residential, commercial or industrial structures.

To get this loan, you would have to build or fix up property in an American Ghetto….

Funny, all the pictures of homes I see that have been foreclosed on, are definitely NOT in the ghetto.

Is there no shame in the face of a Republican? To spread this lie, on a program that cleans up neighborhood infested with crime only to move the blame from the Bank who asked a person to sign on the dotted line…and his most profitable loans – Sub Prime w/ARM –

Do you think that 25% of all the defunct loans were in downtown Detroit?